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An institutionalized system of skewed incentives allowed Wall Street bankers and other corporate executives to gamble with America's wealth and then get away largely scot-free after the house of cards came tumbling down, plunging the U.S. into the worst economic crisis in decades and destroying trillions of dollars of wealth worldwide.

That's the analysis of Joseph Stiglitz, an internationally renowned economist and winner of the 2001 Nobel Prize in economics. (His latest book, Freefall: America, Free Markets, and the Sinking of the World Economy, is just out in paperback.)

During a wide-ranging interview with DailyFinance at AOL headquarters in New York City this week, Stiglitz, who served as chief economist of the World Bank from 1997-2000 and is currently University Professor at Columbia University, explained how the availability of cheap money (thanks in large measure to former Fed Chairman Alan Greenspan), combined with outright mortgage fraud and deceptive and predatory lending practices put millions of people into homes they couldn't afford and caused real estate prices to skyrocket. That created a bubble that would inevitably pop. (See video below, or read the full interview transcript.)

"Festering For Years"

"We have to understand that the problems have been festering for years, not just the last three years," said Stiglitz. "In the years prior to the breaking of the bubble, the financial industry was engaged in predatory lending practices, deceptive practices. They were optimizing not on producing mortgages that were good for the American families but in maximizing fees."

Meanwhile, stock-based compensation created further skewed incentives by encouraging executives to pursue short-term stock gains at the expense of long-term corporate sustainablity, Stiglitz said, and in some cases encouraged them to deceive their own shareholders.

Highly complex financial instruments and off-balance-sheet transactions allowed the bankers to keep much of their activity hidden from woefully understaffed regulators at the SEC and other supposed financial watchdog agencies. And if the regulators did catch some fraud, Stiglitz explained, the system of penalties generally meant a small fine relative to the full ill-gotten gains, often in the hundreds of millions of dollars.

"Still Home Sitting Pretty"

Legal penalties for financial fraud in the U.S. have become "just a cost of doing business," Stiglitz said. "It's like a parking fine. Sometimes you make a decision to park knowing that you might get a fine because going around the corner to the parking lot takes you too much time."

"We fine them, and what is the big lesson?" said Stiglitz. "Behave badly, and the government might take 5% or 10% of what you got in your ill-gotten gains, but you're still sitting home pretty with your several hundred million dollars that you have left over after paying fines that look very large by ordinary standards, but look small compared to the amount that you've been able to cash in."

Taken together, Stigliz said, this system of widespread fraud, lax regulation and non-deterrent enforcement, created a system of skewed incentives that rewarded criminality, gambling and other bad behavior, and left American workers, investors and homeowners holding the bill.

Meanwhile, the astonishingly disproportionate influence of the big banks and corporations on the American political system has allowed powerful executives to exert their will on the U.S. government at the expense of the people, Stiglitz said.

"Five or Six Banks Equal to 300 Million People"

"Look at the regulatory reform that got passed," said Stiglitz. "It was an intense battle. And you had on one side a few banks. And on the other side you had 300 million people, American people. And it was really right in balance. Five or six banks equal to 300 million people. And in the end we got what you might call an unsatisfactory compromise."

Stiglitz doesn't buy the argument that trying to restrict corporate political donations would somehow infringe on the free speech of corporations, as the U.S. Supreme Court recently ruled in the landmark Citizens United case, a decision that busted open the door to a flood of corporate political donations.

"Corporations are a legal entity," Stiglitz explained. "We create them. And when we create them we create all kinds of rules. They can go bankrupt. And that means they owe more money and they get away scot-free. They can create an environmental disaster, and then go bankrupt and again go away scot-free. So, as legal entities we have the right to make the rules that govern them."

"As individuals we have certain basic rights," Stiglitz continued. "We aren't created by the law. We exist by nature. But corporations are man-made. They are supposed to serve our interest, our society's interests. And we are creating them with powers that are not serving our society's interests."

"A Vicious Cycle"

Unfortunately, he continued, we now have a situation where the owners of major American corporations, the shareholders, have virtually no say in compensation, the very thing that created many of the skewed incentives that led to the bad behavior.

"If you're going to rob your shareholders, shouldn't they have the right to say I don't like this?" asked Stiglitz. "It's basically a vicious cycle in which we've gotten ourselves, because the corporate executives control the corporations. The corporations have the right to give campaign contributions. So basically we have a system in which the corporate executives, the CEOs, are trying to make sure the legal system works not for the companies, not for the shareholders, not for the bondholders -- but for themselves."

"So it's like theft," said Stiglitz. "These corporations are basically now working for the CEOs and the executives and not for any of the other stakeholders in the corporation, let alone for our broader society."

What should be done? "I think we ought to go do what we did in the S&L [crisis] and actually put many of these guys in prison," said Stiglitz. "Absolutely. These are not just white-collar crimes or little accidents. There were victims. That's the point. There were victims all over the world."

A Theory of Justice

Among the casualties of this whole mess, according to Stiglitz? Faith in the legal system itself. "The legal system is supposed to be the codification of our norms and beliefs, things that we need to make our system work," he said. "If the legal system is seen as exploitative, then confidence in our whole system starts eroding."

"When you say the Pledge of Allegiance, you say, with 'justice for all," Stiglitz said. "People aren't sure that we have justice for all. Somebody is caught for a minor drug offense, they are sent to prison for a very long time. And yet, these so-called white-collar crimes, which are not victimless; almost none of these guys, almost none of them, go to prison."

"Families are as important as corporations," he said. "Keeping kids in school, not forcing them out of their home, keeping the community together, is certainly as important as keeping a corporation alive."

Thank you Mr. Stiglitz, I agree with you 100% Jail time. There is no difference between a man/woman who ruins my retirement fund or fakes info on mortgages and a guy snatching my pocketbook or stealing my credit card. Why do white collar criminals get off with a slap on the wrist??? Look what has happened to these "executives", how many of them are walking around free and clear. In fact how many of them have gotten bonus's that would keep a family of five alive for a year or so! No wonder everybody wants to come to America, put on a suit and tie and you can cheat, rob, lie and steal and probably get a heafty bonus for it! Holy S#$@! no wonder we're going to Hell in a Bread Basket!!

Someone in jeans breaks into your car and steals a few dollars and goes to jail. Someone in a suit sits behind his desk and steals millions from many people and gets a bonus and golden parachute. Liberty and justice for all? I think not.

The suit's behaviour closely resembles that of a Schreibtischäter (roughly translated as "desk perp" or "paper-pusher perp"). Wikipedia describes a Schreibtischtäter as follows: A desk perp is someone who exploits the state's power structure to have crimes committed against another person. Adolf Eichmann and Heinrich Müller are often cited as desk perps. In France, Maurice Papon is fingered. Those responsible for the shoot-to-kill commands in the GDR also belong to this group. -- http://de.wikipedia.org/wiki/Schreibtischt%C3%A4ter

Sounds like all political parties bear some responsibility for allowing decent Americans to be systematically exploited for the profit of a few. The persistent glorification of debt as a way to do business (by banks, government, all of us) has left people broken, families ruined, weddings postponed and retirement delayed, schools out of reach and illnesses untreated. But the banks still stand proud: fat, sly and smiling. Now that unknown amounts of money can be spent by unknown institutions and individauls, sowing divisiness is now good political strategy. The more extreme the political conversations become, the less attention is paid the "the man behind the curtain." Average Americans need to know who that man is. Be it banks, and their chief exploitation officers, the Chinese, shadow political factions etc. But to both Republicans and Democrats - your enemy is not each other. Your enemies are the institutions that are buying, selling, and swapping you and your influence. For the calm, sane Americans out there: check motives behind political situations and these elections. Ask for the facts. Be skeptical. Evaluate calmly in light of your experience, education, and common sense. We are America's last hope.

Stiglitz is exactly right, only problem is even he buys into the "minor drug offenders in jail" propaganda of the last 5 years. White Collar Crime as Banking, Fraud etc is often called by local, state and feds, has long been growing at both the top end and the low end. Problem is any accountability is lost with complex new law added to basic existing law, with no two lawyers agreeing on what is legal and the court system and enforcement unable to handle or deal with the volume of even the cases that are sent in. These drug cases are just like the Fraud cases, multiple violations and technicalities or charges reduced down to the lowest or cheapest punishment, because juries don't understand the complexities, or the cases never see court and its easier to reduce down to the plea bargain level, just to get some time, some fine or on a subjects record. The bottom line has been for Judges, DA's, and States Attorneys, to free the jails up of over crowding. Also, when law enforcement of any type is not funded to handle every new law or regulation that has been passed by Congress or the States, its like everyone assumes that "ACCOUNTABILITY" can be accomplished equally, on top of all existing law, with the same small or large staff for enforcement! Often Criminal and particularly White Collar Crime of any type, is legislated with no money for additional staff for the complex and confusing legislation. AS with the recent "banking reform bill" , money will be spent on boards and commissions, but how many new federal auditors staff, LE officers, GAO or Securities etc positions were funded to do the work? OR Prisons to handle the swindlers along with the embarrasing ankle monitors that seems like a additional retribution for white collar offenders, with larger fines. His point of "unequal justice and unequal enforcement" is exactly what everyone else is seeing and complaining about after the Black Panther, ACORN, Barney Franks, HOLDer and GEITHNER debacles, where Justice has been subverted in thousands of ways, where non feisance and failure to even investigatte federal crimes or shift them to "Ethics" committees, rather than Law enforcement or Federal dropping of charges aganst politically connected donnors, or even failing to even investigate a Large NON PROFIT like ACORN by IRS or FBI, across state lines and finances, has totally alerted everyone to the basic Constitutional Intention of EQUAL JUSTICE and no one above the law or below the law theroy. I noticed to this day, ridiculous "pushing" and selling by banks and mortgage sellers, of Adjustible Rate Loans and "no interest loans". Once I had to demand a Supervisor on the phone to just get the daily rate on a 15 year fixed loan, the Banks customer service rep just kept trying to tell me the benefits of low monthly payments, 0 interest (HA) and even after telling her I didnt care about the monthly payments, was very familiar with the mortgage system, she finally had to admit she didnt know much or the rates for conventional 30-15 fixed loans. GEEEZ Its still going on today! Advertising and Marketing from Banks has totally harmed customers with no experience with buying and refi's, and they trust that Banks knowledge rather than their "sell" marketing objective. Its ridiculous. Also when the Banks did away with "assumeable loans" they did a disservice to young and old, who could save on closing costs and fees, were willing to save for their home, yet were cut out of the possibility of lower interests during the Inflation of the 80's, because loans had the "no assumption" clause written into them. Advarice and stupidity by Congress in complicating and regulations with intent to social manage rather than fiscal responsibility, has frustrated accountability for a long time. Stiglitz is absolutely right about disparate punishment and treatment, but without a Lesson and ENforcement of basic Law on the Congress that manipulates and controls national banks, sec etc whats to stop the total collaspe and trust left, in Constitutional Principles of equal justice???? Tough Love and Accountability are both dependent upon enforcement ability and follow through. How many Civil Liability suits by ACLU or other Trial Lawyers have been filed for NON FEASANCE by S>E>C>, FBI, or any other agency charged with accounting, enforceing or investigating the white collar crimes on the Books equally?

Ron Paul, Peter Schiff, Jim Rogers... said what was coming years ago and the media & puplic gave them a patronizing pat on the head with a pitying smile. But now that a NOBEL prize winner says the same thing well now that's NEWS and everybody is listening. U.S. citizens deserve what they get. They think well "I pay taxes & vote, my job is done." Wrong... the gov. & the elites that keep them office have to watched and ran "rough shod" over constantly. Otherwise they're like kids in the candy store... and on YOUR NICKEL.

I'll be 54 this week. Neither individuals nor the government has supported me since that day in the 1970's when I graduated from college. Other than my mortgage, I have no debt and I have money in the bank and in retirement accounts and in eleven years and a few days, I will collect a defined benefit retirement as well as Social Security. I raised my kids as a single father and they have been self sufficient adults for years. Almost every Republican I know has a lovely home, late model vehicles, nice wardrobes, plenty of food in their pantry and money in the bank. Our forebears having provided us with such great opportunity, how can you be out there demanding tax cuts when we are trillions of dollars in debt? Tax cuts for the prosperous create jobs? Think I'm a fool; tax cuts for the wealthy end up being hoarded by the recipients. The lifestyles we have been able to lead are unmatched in all of history. When so many of us have had incredible opportunity to prosper, how can we not be our brother's keeper? Before you go out there on the first Tuesday in November and vote for unbridled greed THINK.